Slow marketing sales of existing projects since the beginning of 2017 and a shift to lower-priced apartments could reduce Lippo's profit margins, EBITDA, and interest servicing capacity beyond our tolerance for the 'B+' rating through 2018.

The proposed rights issue at Lippo's healthcare unit Siloam within the next three months and potential ownership dilution could also limit Lippo's future financial maneuverability.

The CreditWatch indicates a one-in-two likelihood of a one-notch downgrade within the next three months, pending a review of Lippo's revised project launches and its impact on profit margins, the outcome of Siloam's rights issue, and the company's financial policies and growth ambitions.

We placed the ratings on CreditWatch because we believe Lippo's interest servicing capacity and financial flexibility could reduce due to subdued operating conditions, potentially weaker operating margins, and the outcome of a proposed rights issue at its healthcare subsidiary PT Siloam International Hospitals Tbk. (Siloam).

We had expected a bottoming of property sales for rated Indonesian real estate developers in 2016, arising from the uncertainty associated with a tax amnesty. Our property sales forecasts had assumed a gradual improvement in market sentiment and sales in 2017 and 2018 from the gradual resolution of the tax amnesty and new project launches by developers.

So far, however, rated and listed developers have generally announced few project launches and consumer sentiment toward large-ticket item purchases such as real estate remains muted. Realized marketing sales from both new projects launches and existing inventory for the first six months of the year have therefore been slow and lagged their full year projections. Most developers have resorted to land sales to mitigate some shortfalls in sales targets.

Amid weaker marketing sales of existing projects for the six months ended June 30, 2017, Lippo launched lower priced apartments at its Meikarta development in Cikarang. This first launch of lower priced apartments has met with relative success with Lippo employees. Nevertheless, we note that the lower selling prices of these apartments will translate into lower consolidated profit margins and EBITDA through 2018. Along with subdued property sales since 2015, we believe Lippo's reported EBITDA in 2018 could be substantially lower than we earlier anticipated. The company's EBITDA interest coverage could therefore fail to be comfortably above the 1.5x level we would consider for the rating to stay at 'B+'.

Lippo also experienced delays in the sale of some of its malls to its listed REITs in Singapore. For example, the company originally expected its sale of a mall in Yogyakarta in mid-2016, but it gradually pushed the timeline to early 2017 and now to the end of 2017. The ability of Lippo's credit metrics to stay within out tolerance level for the 'B+' level also hinge on those substantial asset sales.

In our base case, we expect Lippo to sell the Yogyakarta mall in early 2018 and part of the St. Moritz complex, in Jakarta, in 2019. But we recognize that the sales will also depend on the ability of the Singapore REITs, especially Lippo Malls Indonesia Retail Trust (LMIRT), to absorb more assets without a corresponding equity issuance, in our opinion. Such activities take time and may delay completion of the acquisitions.

In July 2017, Siloam announced a proposed rights issue. The company intends to use the proceeds from the rights issue to expand its operations, via a combination of construction of new sites and acquisitions of existing hospitals. At present, it has 31 hospitals in 16 provinces and plans to increase its portfolio to 50 hospitals in 34 provinces by 2019. It remains unclear at this stage how much Siloam is likely to raise and whether Lippo will keep its stake in Siloam as it is or reduce it after the rights issue.

A further dilution in Lippo's stake in Siloam post the latter's right issue would be credit negative, in our opinion. While it may be cash flow neutral for Lippo, we have highlighted before that a dilution of Lippo's stake would effectively reduce the level of Lippo's assets and listed stakes that it could monetize to consolidate its balance sheet. A dilution, if it occurs, would also come after a previous reduction in Siloam's stake to about 62% from 70% in August 2016. This would reduce Lippo's financial flexibility amid slower operating conditions domestically in the real estate development segment. Finally, it would also further demonstrate the company's aggressive growth aspirations.

The CreditWatch status indicates a one-in-two likelihood of a one-notch downgrade within the next three months. We will seek further clarity on the following: (1) The prospects for Lippo's marketing sales, especially at the Meikarta project; and (2) the ultimate ownership of Siloam post the company's rights issue. In considering these factors we will also take into account Lippo's willingness to protect its balance sheet and maintain sufficient financial flexibility while continuing its expansionary strategy at its healthcare operations.

We will also assess the implications of Lippo's strategic shift toward lower margin apartments in Meikarta and its impact on margin and profit generation through 2018.

We may lower the rating, most likely by one notch, if our projections indicate that the company's EBITDA interest coverage ratio will fail to stay comfortably above 1.5x on a sustained basis. This would most likely materialize if marketing sales remain slow through the end of 2017 or overall profit margins are indeed materially lower than those of past projects. A reduced ownership stake in Siloam with funds employed for expansion rather than reducing debt could also impact Lippo's future financial flexibility in times of strained cash flows as the limited debt headroom of its REITs constrains future acquisitions.

A rating affirmation at 'B+' would be contingent upon (1) a substantial pickup in marketing sales, or increase asset sales allowing the company to generate improve absolute EBITDA such that its EBITDA interest coverage stays comfortably above 1.5x on a sustained basis; and (2) the company maintaining appropriate financial flexibility.

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